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FRM Part II · FRM Exam Part II · Early Warning Indicators

A bank's liquidity risk team observes the following over one quarter: the loan-to-deposit ratio rose from 82% to 91%, the share of deposits that are insured fell from 60% to 48%, retail deposit rates were raised above peers, and the average maturity of wholesale funding shortened from 140 to 55 days. Each indicator remains inside its hard limit. Which interpretation is most appropriate?

The combined movement points to rising funding fragility and should be escalated, even though no hard limit is breached. Higher lending relative to deposits, less insured funding, above-peer deposit pricing and shorter wholesale maturities together indicate growing reliance on less stable funding, which is what early warning indicators should detect.

  1. AThe combined trend signals rising funding fragility, so the indicators should be escalated together even though no single limit is breachedCorrect
  2. BNo action is needed because no individual limit has been breached
  3. COnly the loan-to-deposit ratio matters because it is the only balance sheet ratio
  4. DThe higher deposit rates show improved franchise strength, offsetting the other trends

Explanation

The trends together suggest greater reliance on less stable, shorter funding paid for at above-market rates, which is a classic sign of pressure. EWIs are meant to capture direction and clustering, not only limit breaches. Above-peer deposit pricing typically reflects funding difficulty, not strength.

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